Inflation "re-ignites"! The breakdown of negotiations between the US and Iran shatters expectations of interest rate cuts, causing bond traders to urgently postpone the rate cut to 2027.

The failure of the US-Iran peace negotiations further shifts the focus of the bond market towards inflation and reinforces the expectation that interest rates will remain high for a longer period of time. The rise in energy costs may exacerbate the already high price pressures and delay the interest rate cut by the Federal Reserve, which is the most core concern for the $31 trillion US Treasury bond investors. Traders and strategists from Pacific Investment Management Company (PIMCO), Brandywine Global Investment Management, and Natixis North America are on high alert, expecting that yields will continue to operate at high levels until the inflation outlook becomes clearer, most institutions are reluctant to make major adjustments to their asset allocation. The inflation data for March released on Friday showed that the month-on-month increase in the Consumer Price Index (CPI) reached a new high since 2022, pushing the yield on 10-year US Treasury bonds above 4.3%, prompting traders to lower their expectations for rate cuts this year. On Monday, after the US-Iran weekend negotiations collapsed, President Trump ordered the blockade of the Strait of Hormuz, causing yields to rise further by 3 basis points to 4.35%. John Briggs, head of US rate strategy at Natixis North America, pointed out: "The wind has indeed shifted back to the inflation field. Although the job market is stable, there is a lack of structural vitality, and current inflation is the core issue." This shift highlights the rapid turn of the market narrative: oil prices are already much higher than before the conflict, and inflation issues are becoming increasingly hard to ignore. For many investors, they must also deal with the risk that the prolonged conflict may eventually drag down economic growth, so the more urgent issue is how long the high energy costs will continue and eventually transmit to consumer prices. The yield on Japan's 10-year government bonds climbed to its highest level since 1997, while the yields on equivalent-term government bonds in Australia and New Zealand rose by at least 6 basis points. At the same time, the US labor market remains robust. The increase in non-farm payrolls in March reached its highest level since the end of 2024, with the unemployment rate dropping to 4.3%, making the argument for a rate cut more complex. Kevin Flanagan, head of investment strategy at WisdomTree, said that it would take at least three months to obtain clear inflation data. He added that because the inflation rate is still about one percentage point higher than the Federal Reserve's target and the unemployment rate remains near 4.5%, the urgency of considering a rate cut from this level has diminished. Traders have adjusted their expectations, pushing back the timing of the next 25 basis point rate cut by the Federal Reserve to mid-2027. The market had previously expected two rate cuts this year before the conflict, but the Federal Reserve has stood still since lowering its policy range to 3.5%-3.75% in December last year. Meanwhile, unresolved issues such as the ceasefire, the situation in the Strait of Hormuz, and the trend of oil prices continue to put pressure on the front end of the US government bond yield curve, and expectations for monetary policy remain unstable. Andrew Jackson, chief investment officer at Vontobel, said: "To some extent, the Fed's job has become slightly easier because they can say there is uncertainty in the medium-term inflation trend." He pointed out that the Fed is "very likely to pause rate hikes for longer than previously expected," making the yield curve from three years to five years more attractive. Others are content to stay on the sidelines for now. Jack McIntyre, portfolio manager at Brandywine Global Investment Management, said he is currently underweight US government bonds. "If the ceasefire continues and oil prices continue to perform poorly, the market will refocus on the labor market. If things change, we will adjust our views quickly." The March inflation report showed a 0.9% month-on-month increase in prices, driven mainly by a surge in gasoline prices, while core prices excluding food and energy were slightly lower than expected. This increase is in line with expectations, as many companies, including Delta Air Lines and the US Postal Service, have signaled price increases. Molly Brooks, US rate strategist at TD Securities, said: "Without deterioration in economic growth, the Fed needs to see inflation surge lower and several reports showing moderation before they feel comfortable continuing to cut rates. Although recent labor market data shows resilience, the Fed's dual mandate is becoming increasingly important." Minutes from the Fed's March 17-18 meeting showed that officials saw two-way risks before the conflict erupted, with "the vast majority" of officials mentioning the upward risk of inflation and the downward risk of employment. Daniel Ivascyn, CIO of PIMCO, said that the surge in energy prices has exacerbated this tense situation, leading to a "supply-side inflation shock." He said: "Currently, with high and sustained inflation, and financial assets generally weak, this is indeed a reasonable market risk." The company prefers high-quality bonds while seeking profit from any market discrepancies. In the backdrop of continuously changing Fed policy prospects, there is still an anchor point: since mid-2023, the yield on 10-year US Treasury bonds has mainly fluctuated between 4% and 4.5%, averaging around 4.25%. Flanagan said: "There are still many uncertainties at the moment, and the yield on the 10-year government bond has returned to the middle of its long-term range."